Principles of Microeconomics: Final Exam Study Guide

Chapter 4: Demand, Supply, and Equilibrium

Law of Demand, Demand Schedule, and Demand Curve

The law of demand states that, all else equal, as the price of a good increases, the quantity demanded decreases, and vice versa. The demand schedule is a table showing the quantity demanded at various prices. The demand curve is a graphical representation of the demand schedule, typically downward sloping.

• Law of Demand: Inverse relationship between price and quantity demanded.

• Demand Schedule: Tabular representation of price and quantity demanded.

• Demand Curve: Downward sloping curve on a price-quantity graph.

• Example: If the price of coffee rises from $2 to $3, the quantity demanded falls from 100 to 80 cups per day.

Market Equilibrium

Market equilibrium occurs where the quantity demanded equals the quantity supplied. At this point, there is no tendency for price to change.

• Equilibrium Price: The price at which Qd = Qs.

• Equilibrium Quantity: The quantity bought and sold at the equilibrium price.

• Example: If at $5, Qd = 50 and Qs = 50, the market is in equilibrium at $5 and 50 units.

The Definition of Markets

A market is any arrangement that allows buyers and sellers to exchange goods and services. Markets can be local, national, or international.

• Key Features: Buyers, sellers, and a product or service.

• Types: Physical (farmers' market), virtual (online marketplaces).

Law of Supply, Supply Schedule, and Supply Curve

The law of supply states that, all else equal, as the price of a good increases, the quantity supplied increases. The supply schedule is a table showing quantity supplied at various prices. The supply curve is an upward sloping graph of the supply schedule.

• Law of Supply: Direct relationship between price and quantity supplied.

• Supply Schedule: Table of price and quantity supplied.

• Supply Curve: Upward sloping on a price-quantity graph.

Market Disequilibrium: Surplus and Shortage

When the market is not at equilibrium, there can be a surplus (excess supply) or a shortage (excess demand).

• Surplus: Occurs when Qs > Qd at a given price (price above equilibrium).

• Shortage: Occurs when Qd > Qs at a given price (price below equilibrium).

• Example: If at $10, Qs = 100 and Qd = 60, there is a surplus of 40 units.

Outside Factors Affecting Demand and Shifts of Demand Curve

Factors other than price can shift the demand curve, such as income, tastes, prices of related goods, expectations, and number of buyers.

• Increase in Demand: Demand curve shifts right.

• Decrease in Demand: Demand curve shifts left.

• Example: A rise in consumer income increases demand for normal goods.

Relevant Formulas (Chapter 4)

• Market Equilibrium Condition: $Q_d = Q_s$

• Shortage: $Q_d - Q_s$ (occurs when price is below equilibrium)

• Surplus: $Q_s - Q_d$ (occurs when price is above equilibrium)

Chapter 6: Sellers and Incentives

Producer Surplus

Producer surplus is the difference between the price a seller receives and the minimum amount they are willing to accept (marginal cost).

• Individual Producer Surplus: Area between the price and the marginal cost curve for the firm's quantity.

• Market Producer Surplus: Area between the market price and the market supply curve.

Total, Fixed, and Variable Cost

Firms face different types of costs in production:

• Total Cost (TC): The sum of all costs incurred in production.

• Fixed Cost (FC): Costs that do not vary with output (e.g., rent).

• Variable Cost (VC): Costs that change with the level of output (e.g., raw materials).

• Formula: $TC = VC + FC$

Key Characteristics of Perfectly Competitive Markets

Perfect competition is a market structure with many buyers and sellers, identical products, and free entry and exit.

• Many buyers and sellers

• Homogeneous products

• Free entry and exit

• Price takers: Firms cannot influence market price.

Total and Marginal Revenue

Total revenue (TR) is the total amount received from sales. Marginal revenue (MR) is the additional revenue from selling one more unit.

• Total Revenue: $TR = P \times Q$

• Marginal Revenue: $MR = \frac{\Delta TR}{\Delta Q}$

Profit Maximization and the Optimality Rule (MC = MR)

Firms maximize profit by producing the quantity where marginal cost equals marginal revenue.

• Optimality Rule: $MC = MR$

Relevant Formulas (Chapter 6)

• Average Total Cost (ATC): $ATC = \frac{TC}{Q}$ or $ATC = AVC + AFC$

• Profit (\( \pi \)): $\pi = TR - TC$ or $\pi = (P - ATC) \times Q$

Chapter 12: Monopoly

The Definition of Monopoly

A monopoly is a market with a single seller of a unique product with no close substitutes and high barriers to entry.

• Single seller

• Unique product

• Barriers to entry

Barriers to Entry, Natural Monopolies, Economies of Scale

Barriers to entry prevent new firms from entering the market. Natural monopolies occur when a single firm can supply the entire market at lower cost due to economies of scale.

• Examples: Utilities (water, electricity)

Comparison of Different Market Structures

Market Structure	Number of Firms	Product Type	Entry Barriers
Perfect Competition	Many	Identical	None
Monopoly	One	Unique	High
Monopolistic Competition	Many	Differentiated	Low
Oligopoly	Few	Identical or Differentiated	High

Price Discrimination

Price discrimination occurs when a firm sells the same good at different prices to different consumers. Types include:

• 1st Degree: Each consumer pays their maximum willingness to pay.

• 2nd Degree: Price varies by quantity purchased (block pricing).

• 3rd Degree: Different prices for different consumer groups.

Relevant Formulas (Chapter 12)

• 1st Degree Price Discrimination Profit: $\pi = \text{Total Willingness to Pay} - \text{Total Cost}$

• 2nd Degree Price Discrimination Profit: $\pi = (\text{Revenue from Block 1} + \text{Revenue from Block 2} + \ldots) - \text{Total Cost}$

• 3rd Degree Price Discrimination Profit: $\pi = (\text{Revenue from Group A} + \text{Revenue from Group B}) - \text{Total Cost}$

Chapter 9: Externalities and Public Goods

Properties of Goods: Rivalry and Excludability

Goods are classified based on rivalry (whether one person's use reduces availability for others) and excludability (whether people can be prevented from using it).

Type of Good	Rival?	Excludable?	Example
Private Good	Yes	Yes	Ice cream
Public Good	No	No	National defense
Common Resource	Yes	No	Fish in the ocean
Club Good	No	Yes	Cable TV

Common Goods, Tragedy of the Commons, and Solutions

Common goods are rival but not excludable, leading to overuse—a problem known as the tragedy of the commons. Solutions include regulation, privatization, or community management.

Externalities: Positive, Negative, and Pecuniary

An externality is a cost or benefit imposed on others not involved in a transaction.

• Negative Externality: Pollution from a factory.

• Positive Externality: Vaccination benefits others.

• Pecuniary Externality: Market price effects (e.g., increased demand raises prices for others).

• Remedies: Taxes, subsidies, regulation, or tradable permits.

Relevant Formulas (Chapter 9)

• Marginal Social Cost (MSC): $MSC = MC + MEC$

• Marginal Social Benefit (MSB): $MSB = MB + MEB$

Chapter 8: Trade

Arguments Against Free Trade

Common arguments include protecting jobs, national security, infant industry protection, and preventing unfair competition.

Comparative Advantage and Absolute Advantage

Comparative advantage is the ability to produce a good at a lower opportunity cost than others. Absolute advantage is the ability to produce more of a good with the same resources.

• Example: If Country A can produce wheat at a lower opportunity cost than Country B, A has a comparative advantage in wheat.

Tariffs and Their Effects on Welfare

Tariffs are taxes on imports. They raise domestic prices, reduce imports, and generate government revenue, but can cause deadweight loss.

• Tariff Revenue: $\text{Tariff Rate} \times \text{Quantity of Imports}$

• Deadweight Loss: Loss of total surplus due to market distortion.

Trade Between Countries and Welfare Effects

Trade allows countries to specialize according to comparative advantage, increasing total welfare. However, some groups may lose from trade (e.g., workers in import-competing industries).

Relevant Formulas (Chapter 8)

• Opportunity Cost of Good A: $OC_A = \frac{\text{Quantity of Good B Given Up}}{\text{Quantity of Good A Gained}}$

• Tariff Revenue: $\text{Tariff Rate} \times \text{Quantity of Imports}$

• Quantity of Imports: $Q_{demand} - Q_{supply}$ (at the world/tariff price)

• Quantity of Exports: $Q_{supply} - Q_{demand}$ (at the world price)

Geometry for Surplus and Welfare

• Consumer Surplus: Area below the demand curve and above the market price.

• Producer Surplus: Area above the supply curve and below the market price.

• Area of a Triangle (Consumer Surplus, Producer Surplus, Deadweight Loss): $\text{Area} = \frac{1}{2} \times \text{Base} \times \text{Height}$

• Area of a Rectangle (Tariff Revenue): $\text{Area} = \text{Base} \times \text{Height}$

Additional info: This guide covers the most frequently tested concepts and formulas for the final exam in Principles of Microeconomics, focusing on demand and supply, market equilibrium, costs and revenues, monopoly, externalities, public goods, and international trade. Students should be prepared for both conceptual and calculation-based questions.